Angel Tax Credit stimulates early startup investors in Tennessee

Between FedEx, five Class A railroads, the Interstate-40 transcontinental artery, and countless warehouses, freight cuts a huge slice of Memphis’ economic pie. While there are many large employers, there are many supporting businesses too.

One of them is A3 Freight Payment, a growing business that has benefitted from a new State of Tennessee program intended to boost native angel investment.

“We are a business to business service company serving as an outsourcer for their accounts payable related to freight and transportation invoices,” said co-founder and CEO Ross Harris. “We are definitely in a niche industry.”

Along with three partners, Harris started A3 Freight Payment in 2012. All veterans to the freight payment industry, they pooled their experience and Rolodexes. Headquartered in the Southwind area of Memphis, the company is geared toward the needs of large volume shippers. It can process $3 to $5 billion annually.

When they hung their shingle, they initially sought investment from other industry insiders. After steadily building clientele, their growth spiked last year. More capital was needed. The partners wanted keep their core group of investors close, though.

“One of the ironies of a successful business is about the time you are about to hit your stride is when you need more capital to cover the growth, especially in a service business like ours,” said Harris.

On January 1, 2017 businesses like A3 Freight Payment were thrown a lifeline by the Tennessee Legislature with the Angel Tax Credit.

Passed in 2016, it connects investors with pre-qualified startups seeking capital. In addition to seeding entrepreneurship, it was created to keep companies from the leaving state. Individual investors receive a 33 percent tax offset.

“We’ve been one of the fastest growing states as it relates to startup investments in the Southeast for the last five years. To keep that momentum going, we need to encourage capital investment in Tennessee startups."

Tennessee is one of 19 states to offer a similar program. Gov. Bill Haslam's Administration threw in their support and resources to get the incentive passed last year.

Forty-two companies have been pre-approved in the state. Twenty have seen investors redeem credits. Two A3 Freight Payment investors have redeemed a combined $100,000 worth of tax credits.

“The Angel Tax Credit has allowed our investors to put in more money because they are bolstered by the credit now,” said Harris.

So far, $1.32 million in tax credits have been approved, while $4.75 million in new investments have been added to the state’s economy.

“Given that the world of startup investment is risky, the tax credit essentially de-risks that investment, to some degree, and helps encourage new investment,” said John Lanahan, director of capital formation at LaunchTN. “It helps get people off the sidelines who haven’t typically invested in startups before.”

Related: "Memphis Money: Investment pipeline for startups has room for improvement" 

Launch Tennessee is a public-private partnership that supports entrepreneurship in the state. It encourages collaboration among entrepreneurs, businesses, capital and other stakeholders.

“Angels [investors] largely serve this pre-seed stage before a company is ready to raise a formal seed round. So, more angels translates to more capital available for startups, which is the number one thing startups say they need,” said Lanahan.

Ross Harris is the co-founder and CEO of A3 Freight Payment. His company took advantage of the Angel Tax Credit this year to help spur capital investment to grow his business.Investors can receive up to $50,000 in credits per year. They apply to Hall income tax liabilities, which is a 6 percent tax levied by the state on investment income.

Credits can be carried forward into future tax returns as well. It may be retroactively applied if investor and company are qualified by December 31.

The program is capped at $3 million this year, with $1.68 million in credits left. They expire if no one qualifies by the end-of-2017 deadline. The cap will rise in succeeding years. Next year, four million will be dedicated to the program. In 2019, it will see a bump up to $5 million and stay at that level.

The program will expire along with the Hall income tax in 2022.

“We’ve been one of the fastest growing states as it relates to startup investments in the Southeast for the last five years. To keep that momentum going, we need to encourage capital investment in Tennessee startups,” said Lanahan.

Investment in nascent businesses has trended upward in Tennessee since 2012. Investment dollars have grown from $250 million to $450 million in that timeframe, according to Launch Tennessee. However, a drop off is underway that is following a larger trend across the region.

“Angels really are a critical resource to help companies get off the ground,” said Lanahan.

While an infusion of much of capital would make a lot of burgeoning business people jump through countless hoops, the application process isn’t too onerous. The first step is an evaluation. The appraisal also gives entrepreneurs a chance to improve their businesses and sharpen their pitches.

“I’m trained as a CPA and having gotten a taste of tax compliant work, this process paled in comparison to that level of complexity. It’s pretty straightforward,” said Harris. 

Qualifying companies must be less than five-years-ol, with revenues under $3 million the previous year. They may have 50 or fewer employees. Sixty percent must perform the majority of their work in Tennessee. Further restrictions favor high-growth technology companies.

“When investing in early-stage startups, there is a relatively, high likelihood that they could fail since it is so early. The Angel Tax Credit give that investor some buffer on the potential downside. It helps them decide they can stomach the risk because they know there’s this offset,” said Lanahan.

“We are always looking for ways to get companies off the ground and surround them with needed resources.”

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